What is the Options Wheel Strategy in Trading? How it Works?

Jesse Anderson

Published on March 17, 2022

In today’s trading environment, many investors are looking for strategies to maximize the income they earn on their portfolios. Frequently, they are looking for a strategy that can earn a better return than simple passive investing in dividend stocks or bonds but which also doesn’t require heavy volumes of option trading. Fortunately, there is a strategy that can offer the ability to achieve both of these goals: the option wheel strategy. Let’s take a few moments to discuss it.

What is the Options Wheel Strategy?

The options wheel strategy is a strategy that involves selling the best stocks for cash secured puts and covered calls to generate income on an investment account. The strategy begins by using an option premium screener to locate a stock that the trader is bullish on (i.e. that they believe will go up in value) and which offers option premium that the trader believes will make a trade worthwhile. Many traders will use optionDash to find the best stocks for covered calls and cash secured puts.

After locating an attractive position, the trader will begin the option wheel strategy by selling a cash secured put against that position, at a strike price that the trader is comfortable purchase the stock. More often than not, they begin with an out-of-the-money cash secured put to reduce the chances of assignment. Because the trader is bullish on the position, they are anticipating that it will either remain at the same price or go up in value. At the option expiration, therefore, the hope is that the put contract that is sold will expire without being exercised. The trader will not have to purchase any shares of the underlying stock in this scenario and will be entitled to keep the option premium they were paid as their profit.

If this scenario does occur, the trader can choose what to do after expiration. They may choose to sell another put against the same position (if they are still bullish on its prospects) or they may choose to locate a new position using optionDash or another option premium screener to sell a put against. They will repeat the same process of selling cash secured puts until one is assigned.

If a cash secured put is assigned, the options wheel strategy will simply shift gears. The trader will now own 100 shares of the underlying stock. They can sell a covered call option against the shares at the same strike price that the put was previously assigned at; in addition, they can sell another cash secured put against the position, thus earning two different option premiums in this trade.

The trader will wait to see if either option is assigned at expiration; if the call is assigned, the shares will be sold at the strike price for the call and the option wheel strategy will reset to the start. If neither option is assigned, the trader will sell the same call and put the following expiration period. If the put is assigned, the trader will sell two call options against the average cost of the 200 shares they now own, as well as selling the cash secured put.

Benefits of the Options Wheel Strategy

Trading with an option wheel strategy has a number of benefits to the trader, which we will discuss below.

Income

The chief benefit of the strategy is the consistent income that it can generate for an investment account. The strategy is designed to receive consistent income from the selling of cash secured puts; indeed, the income can even grow if shares are assigned, as the trader will be able to receive multiple premiums from selling both a covered call and cash secured put against the position in that event.

Protection from Price Volatility

In a situation where there is significant price volatility in the market, a trader can use the option wheel strategy to turn this up and down price movement to their advantage. A trader may wish to locate a position that has dropped substantially in value, but which the trader believes will recover in price fairly quickly. This type of position could be optimal for selling a cash secured put against, as it would presumably be less likely to have the option assigned upon expiration.

Even if a put is assigned, the price volatility could be such that a trader would still expect a rise in the short term. This would possibly help with allowing a covered call sold against the assigned shares to be exercised. Therefore, the trader would still be protected and would gain the benefit of earning two option premiums on the put and call sold. These are some of the best stocks for covered calls and the wheel option strategy.

Dollar-Cost Averaging

In a scenario where a trader sees several successive puts get assigned, the option wheel strategy can assist with dollar-cost averaging to reduce the average cost of the shares the trader owns. Each successive put that is assigned will be at a lower strike price than previous ones; this will have the result of lowering the average cost of all of the shares that the trader owns. The hope is that this will help to increase the likelihood of the shares eventually being assigned by a covered call and sold.

Simplicity

Finally, the wheel options strategy is attractive to many investors because of its sheer simplicity. The strategy involves selling one leg options orders, which many investors can sell with relative ease; this is in opposition to many other option strategies, which frequently involve the use of multi-leg options that are only understood by experienced traders. Furthermore, selling the simple options of the options wheel does not take a large time commitment. The options are a semi-passive form of trading; after selling the options, there is nothing further to be done until after the options expiration date has passed.

Drawbacks of the Options Wheel

While there are certainly a number of key benefits to trading the options wheel, there can also be some drawbacks that may discourage certain investors. Let’s take a look at these below.

Ineffective for Smaller Accounts

At the core of the option wheel strategy is the cash secured put; this means that an account trading the options wheel will need to have sufficient cash reserves in order to be able to purchase the shares of stock represented by the put contract if it is assigned at expiration. Depending on what happens with the market and the specific position being traded, it may be necessary to make multiple purchases of stock before the position is closed out requiring significant cash reserves.

This possibility makes it functionally impossible for a smaller account to effectively trade the option wheel strategy.

Stock Ownership

If a trader is averse to actually owning shares of the underlying stock, they will want to avoid the wheel option strategy. The strategy is predicated on taking ownership of the shares of stock if a put contract is assigned at expiration; the only way to possibly avoid this would be to “Buy to Close” the short put position prior to the expiration date. If the position has declined in value to the point where assignment of the put is likely, it will likely cost the trader significantly more premium to buy to close the put option than the trader earned in selling the option to start with. This would leave the trader with a loss.

Limited Upside

The options wheel strategy also has the effect of limiting the possible upside that a trader can receive from the appreciation of a stock.

When selling a cash secure put, the trader receives the premium for the option immediately. However, this will be the maximum profit if the stock remains above the strike price of the put.

When the strategy calls for selling a covered call against the shares that a trader owns after a put is assigned; if the call is assigned, the shares will automatically be sold at the strike price that the call was sold for. If a position happens to appreciate significantly in value prior to expiration, the trader will not be able to share in this appreciation.

optionDash – A Great Resource to Screen Options

Traders using the option wheel strategy will likely find optionDash to be a terrific resource to screen to find the best stocks for covered calls and the best stocks for cash secured puts. A premium subscription to optionDash grants you access to both of our options premium screeners, as well as a wealth of data points on both the options available for a stock and the stocks themselves. The combination of optionDash and the wheel option strategy is a great way for traders to start option trading.